Captives are increasingly essential to health systems’ organizational strategies, particularly corporate risk financing. However, most people do not realize that captives can also serve to foster system growth. While not a cure-all, a captive can help access more sophisticated risk transfer solutions and analytically driven risk retention strategies, reducing an organization’s cost of risk.

Optimally, captives can eliminate silos that exist between property & casualty and employee benefit risks, and become a central repository of risk funding that enables risk managers and senior management to holistically view retained risk. Commercial risk transfer mechanisms can then be accessed in a more nuanced manner across many silos.

How the Affordable Care Act (ACA) impacts healthcare and captive use

Regardless of changes to the ACA (or even its potential repeal), the impetus for changing the reimbursement models and the need for healthcare consolidation will likely continue. Consolidation is accelerating as healthcare organizations seek greater scale to counter a confusing array of market and government pressures. Changing reimbursements, technology, regulations, capital needs, and shifts in patient care have created a state of flux in healthcare that is making organizational independence progressively difficult.

Hospital expansion drivers

The ACA’s complexities, in addition to the proposed large insurance payer deals reported in the press, such as Aetna’s acquisition of Humana and Anthem’s acquisition of Cigna, are prompting health systems to consider expansion to counter the payers’ greater bargaining power. Larger payers will increasingly pressure hospitals and health systems to trim prices by becoming more efficient.

Additionally, providers will gradually shift toward population health management, placing additional attention on size and scale. Although significant fragmentation remains in some markets, this is increasingly rare. We expect to see continued consolidation, especially among large providers with excess capital to deploy. The days of small to midsize community hospitals and physician practices are numbered in the vast majority of markets.

Physician group consolidation

Equally, large physician groups, in response to the changing healthcare environment, are also consolidating to remain as independent, for-profit organizations. Private equity sponsors with an interest in high-quality platform practices are engaging with physicians interested in cashing out of their practices or obtaining growth capital. Our mergers and acquisitions specialists are seeing heightened activity in areas such as urgent care, imaging centers and pain management along with hospital-based practices such as emergency medicine and anesthesiology.

Healthcare M&A by the numbers

Healthcare M&A activity grew by 14 percent last year, to 1,498 transactions, setting a new record for industry deal volume, according to Irving Levin Associates. That compares to 2014, when 1,318 deals were announced across 13 healthcare sectors.

“CONSOLIDATION INCREASES HEALTHCARE SYSTEM RISK AT THE ENTERPRISE LEVEL, LEADING TO GREATER REQUISITE OPPORTUNITIES FOR HOSPITALS TO FINANCE RISK THROUGH THEIR CAPTIVES AND SELF-INSURANCE VEHICLES.”

In 2015, 356 deals involved long-term care entities, 102 for hospitals and 88 for physician medical groups. The year prior, it was 302, 99 and 60, respectively.

In addition to outright acquisitions, hospitals and health systems have implemented or are exploring various physician integration strategies including “employment light” models such as clinically integrated networks, management services organizations, co-management agreements and joint ventures.

Increased concurrent and non-concurrent risk

Consolidation increases healthcare system risk at the enterprise level, leading to greater requisite opportunities for hospitals to finance risk through their captives and self-insurance vehicles to reduce costs and increase revenue. However, healthcare systems’ formal risk management programs generally lag behind consolidation efforts, sometimes substantially. It is not unusual for a healthcare system to fund only its professional/general liability risks through its captive, unchanged from the captive’s formation 15 or 20 years ago when the system was a third of its current size.

Captives can finance more P&C risks

Healthcare system executives commonly ask what risks should be financed in their captives. There is no simple answer, and in fact, it is easier to identify what risks should not be insured in captives.

Larger, more complex healthcare systems pose increased potential for losses from what were once considered esoteric exposures. Cyber events are now considered inevitable, not just possible. In addition, there are regulatory fines and penalties, and wage and hour, reputational, and other risks that represent low frequency but high-severity events that concern healthcare executives. That said, low-frequency, high-severity losses can significantly impact the organization’s balance sheet, but the chances of multiple losses of these types occurring in any given year are relatively remote.

Traditionally, benchmarking trends established by other healthcare systems were used to gauge appropriate risk tolerance. But benchmarking potentially encourages the “lemming effect”. This can leave you wondering whether the surveyed entities are truly representative (eg, the risk appetite of their senior managements, the risks retained in their captives, the sampled entities’ balance sheet strength or their internal rates of return). Instead, healthcare system leadership should consider replacing benchmarking with advanced analytics.

A highly nuanced exercise is needed to determine the amount of risk retained on a per-line and aggregated basis; weigh concurrent versus non-concurrent risks; consider the timing of potential loss payments, and evaluate the capital and potential collateral requirements of increased captive utilization. A comprehensive study in captive utilization will require the services of an experienced broker with deep analytical capabilities, a qualified healthcare captive consultant, and an actuary with expertise across a wide array of risks and skilled captive managers comfortable with implementing new and creative solutions.

Increased third-party utilization

Captive capabilities can also be applied to portfolios of both owned and non-owned risks to increase leverage, optimize the balance of risk retention and risk transfer, allocate risk costs to stakeholders and transfer risks in a more measured manner. This application allows the captive to eliminate leakage (the payment of unnecessary overhead and profit margins to insurers) across related but not necessarily owned facilities and practices, thus contributing to their integrated competitive advantage.

Captives are also used to develop insurance programs that aim to align physicians, employers and other providers to the health systems’ core businesses. The captive supports the growth of the health system by eliminating some of the inherent costs involved in misaligned insurance offerings across various stakeholders, which drives down the cost of risk for the health system and its third-party affiliates.

Emerging interest in health and benefit risks

As healthcare reimbursement models change and hospital employer excess retentions increase, captive consultants are being engaged to include hospital and third-party employer stop loss in captives.

Hospitals are concerned about the risks of overutilization within value-based care associated with bundled payments, capitated contracts and the transition to population health management.

This concern is driving hospital executives to consider their captives as a potential repository for provider stop loss risk, not just employer stop loss and P&C exposures. A captive can serve as an excellent way for healthcare systems to use their own employee base as its training ground for their transitions to population health management before rolling out such programs to the community at large.

The first step in healthcare captive optimization

Healthcare executives may want to engage in a captive optimization study that quantifies the potential cost reductions and revenue enhancements generated by the expanded use of their captives. Such a study will require a healthcare-specific captive consultant with an in-depth knowledge of healthcare exposures; tax-exempt versus for-profit entity implications; onshore versus offshore captive domicile differentiators; stock, mutual and reciprocal risk retention group structures; and state-specific as well as nationwide healthcare trends.

A qualified healthcare captive consultant can clearly outline the scope of services and related costs required to obtain a comprehensive, yet concise, analysis that outlines the benefits and downsides of various enhanced captive utilizations.